A quick Recap

• Why Management Accounting?

• Management Accounting Vs Financial Accounting

• Overview of Course

• What are costs

• Overview of different classification of costs

Chapte-5
• Preparation of Cost sheet. of
textbook
 What is for today?
• What are costs

• Overview of different classification of costs

Lets move the word Cost

COST

Different Cost Frameworks

What are costs?

How are costs classified?

 What is Cost
EXPENSE
What does COST means ? !!!!!
INVESTMENT
Just money !! Cost Vs Price !!

It is usage of resources - Notion of a cost

Cost is the measure of resources given up to achieve a

particular purpose

Actual Vs Budgeted Costs Does the manager needs both?

 What is a Cost Object?

What does COST OBJECT means ? !!!!!

Just PRODUCT

Each item or activity for which costs are measured/assigned is referred

to as a cost object

Can be anything the firm wants to make a decision about

Can be a product, project or other purpose or activity

Different terms in cost
 So tell me?

Management wants to measure the cost of filing individual customer

orders. The costs involved are labor, materials and shipping. What is the
cost object?

a) Labor Cost

b) Material Cost

c) Customer Order

d) Shipping costs
 So tell me?
Cost object examples at Waffel
Cost Object Illustration
Product Rice bowl, Nachos
Service IT support for customer order
Project Chef project on improving taste
Customer Corporate offices – 4 big clients
Activity Leasing trucks
Department Cooking, Catering, Delivery
 What are costing systems? !!!!!
Systems which identify, record and assign expenses related to the acquisition and use of
all kinds of materials and resources.

What resources: raw material, labour, energy, rent, services etc

Used where : different functions like production, sales, human resources and
information technology

Product costing systems involves accounting for the acquisition of resources needed for
production, production process and sale of completed products
 Production Processes
The management team is in a better position to manage these costs if they understand the
relationship of the production process and the types of costs incurred

Based on the production processes, there are two broad costing systems prevalent

• Two basic types of costing systems:

• Job order costing : Arrive at full production cost for one unit of product.
• Process costing : Requires averaging some total costs.
 Approaches to calculate the cost?

Full Costing Activity Based Costing

Depends upon the objective and nature of costs

Will cover towards the later part of the course

Four golden steps in determining costs

Recogniz
e Why need it?

Classify

Assign

Measure/Report
 How are Costs Assigned?
Multiple Ways Direct Costs
1. In Accordance with the Cost Object
Indirect Costs

What are direct costs of my Mug !!

Cost tracing – assigning direct costs to a particular cost object
Material !!
Labour of making the mug !!

Cost assignment
Supervisor salary !!
Utilities !!
Overheads !! Cost allocation – systematic assigning of indirect costs to a particular
cost object
determining costs
 Characteristics of Costs

Direct Costs Which of the following is most probably not a direct product cost?

a) Direct labor cost

Detectable
b) Head Chef salary
Measurabl
e c) Direct materials
cost
Relatively Valuable
Fairly simple right!!
Traceable How to allocate indirect costs?

They are allocated to cost pools/centers

 Were you listening !!
Which of the following costs is least likely to be an indirect production cost?

a) Research director’s salary

b) Factory Rental cost

c) Power cost

d) Factory Manager’s salary

 identify
What are cost pools/centers?

A grouping of individual indirect cost items.

related to an activity such as manufacturing or product testing, or costs related to a

specific department.

Why need cost pools/centers?

Simplify the allocation of indirect costs because the costing system does not have to
allocate each cost individually.
 COSTS
Direct Costs Indirect Costs

Cost Pool using resource driver

Cost Objects using cost driver Cost Objects using cost driver

How many cost pool/centers to use ?

How to assign costs to each cost center or cost pool?

How to assign the costs collected of each cost pool to the products?
 But understand how cost is driven
RESOURCE DRIVERS What is driving the resource (basis on which costs will be assigned)

COST DRIVERS Variable such as level of activity or volume that affects costs over a
given time span. i.e. activities that cause costs to be incurred
Activity Cost Driver

Machining operations Machine hours

Setup Setup hours
Production scheduling Manufacturing orders
Inspection Pieces inspected
Purchasing Purchase orders
Shop order handling Shop orders
Valve assembly support Customer requisitions
 Assigned?
Multiple Ways
2. In Accordance with the Cost Behavior
• How costs are associated with some activity of Interest

• How costs will change in future Any idea what type of

costs it will lead to ????
Why important?

Product Profitability Add or drop a product line

Whether to change product

Whether to Outsource
price
 How are Costs Assigned?

TOTAL FIXED VARIABL

COSTS E COSTS
COSTS
Costs that change with
relation to activity of interest
Costs that don’t change with
relation to activity of interest

Variable costs per Volume of

Mixed Costs !!!!
“Activity” “Activity”
Production Volume and Cost graph !! Unit cost - Variable cost
Production Volume and Cost graph !! Unit cost - Fixed cost
 cost matrix
Relationships of Types of Costs
Assignment of Costs to Cost Object
Waffel
Direct Costs Indirect Costs

Variable Provisions like Services like cooking

Cost Costs Vegetables gas
Behavior

Pattern Labor e.g. : Kitchen Services like insurance

Fixed Costs or Head Chef
Assistants
Does the linear relation holds in reality !!

What about economies of scale ?

Hence, we assume linearity for

simplicity and we focus on a particular
relevant range

Band of normal activity level in which

there is specific relationship between
the level of activity/volume and the cost
in question
That’s all for today’s session
 Cost classification
3. In Accordance with controllability
Controllable cost : costs that a manager can significantly control and influence

Uncontrollable cost : Costs that a manager cannot influence significantly

The question is not, Who controls the cost? but, Who is in the best position to influence the level of a cost item?